Economics
02.03.2023 • 5 min read
Subject Matter Expert
Learn what monopoly in economics is and why it is important. We’ll also go over the types of monopolies, their characteristics, pros, and cons.
In This Article
In economics, a monopoly is a market with one seller and many buyers.
As the sole seller in the market, a monopolist has the power to set prices and earn extraordinary profits at the expense of consumers.
Three main types of monopolies exist.
A natural monopoly is a monopoly that exists either because the first seller to the market controls a limited key resource or because of significant economies of scale and other types of naturally occurring high barriers to entry. A natural monopoly will form in markets if a single firm can serve customers at a lower cost of production than multiple firms trying to do the same.
A legal monopoly is a monopoly that exists because of laws and regulations restrict competition.
Monopolists whose products are protected by intellectual property rights, such as trademarks, patents, and copyrights are good examples of legal monopolies. Legal monopolies can also arise if the costs of complying with government regulations are high. These high regulatory costs create a barrier to entry, which makes it difficult for newer, smaller firms to compete.
A public monopoly is a monopoly run or protected by the government. Government-granted monopolies exist to provide equitable access to necessary goods and services. The postal system, rail service, and utilities like gas, water, and electricity usually operate as public monopoly firms.
Monopoly markets have the following key characteristics:
When economists model monopolies, they assume a single seller exists in the market. A market with only one seller is called a pure monopoly. In practice, policymakers and regulators define monopolies as markets where a single seller dominates the market with a market share greater than 50 percent.
Unlike in perfect competition, where all sellers are price takers, monopolists can set their own prices subject to the market demand curve.
High barriers to entry make it difficult for new firms to join the market and compete with the monopolist. Barriers to entry can take many forms, such as high regulatory costs, laws protecting intellectual property, and high start-up costs.
Monopolists gain market power by producing a good or service without close substitutes. By providing a unique product buyers want, monopolists are shielded from competition.
In your economics courses, you will learn to model monopoly markets using the supply and demand framework.
In a monopoly model, profit maximization occurs at the quantity where the seller’s marginal revenue equals their marginal costs (MR=MC). You can find the equilibrium price by tracing quantity up to the demand curve and then over to the vertical price axis.
Monopolist’s Profit Maximizing Quantity is where MR=MC
Once you find the profit-maximizing price and quantity, you can calculate the monopolist’s profits. Their profits are equal to the area of the rectangle with a width equal to the profit-maximizing price minus average costs (P-AC) and a length equal to the profit-maximizing quantity (Q).
Monopolist’s Profit = Q(P-AC)
Three market structures closely related to monopoly are:
Monopolistic competition is a market where many sellers compete while each producing a slightly differentiated product.
A duopoly is a market where two sellers control the market.
An oligopoly is a market where a small group of sellers dominates.
Monopolies are a matter of considerable political and economic debate. In the real world, a single firm dominates many markets.
In the U.S., antitrust laws were established in 1890 to protect consumers and markets from harmful monopolistic behaviors. The three major antitrust laws in the U.S. are the Sherman Act of 1890, the Clayton Act of 1914, and the Federal Trade and Commission Act of 1914.
In some cases, a monopoly can produce a good or a service at a lower overall cost than multiple firms competing in the same market.
The prospect of earning monopoly profits motivates many businesses to develop new and innovative products that require investment in large fixed costs. Companies earning monopoly profits can choose to invest in further innovation to improve existing products or develop new ones.
According to economists, the main disadvantage of having a monopoly is a profit-maximizing monopolist will charge a high price and produce less than would be the case in a competitive market. This restriction in output usually lowers the total amount of welfare—or surplus—produced in the market.
A monopolist can engage in predatory behavior to protect its monopoly position. Behaviors such as predatory pricing, price fixing, and price discrimination keep new entrants from entering the market and harm consumers.
Legal monopolies shielded from competition might produce inferior products and lose the incentive to innovate.
Monopoly profits can make it attractive for companies with large market shares to merge. Although mergers can be beneficial for consumers, mergers designed to create a monopolistic market can result in inefficiencies and violate the Clayton Antitrust Act.
John D. Rockefeller’s Standard Oil company was the world’s largest oil production company in the late 19th and early 20th century. In 1911, the U.S. Supreme Court deemed it an illegal monopoly. After the ruling, the company was dissolved and divided into 43 separate companies.
The multinational telecommunications company is the largest telecom company in the world today by revenue. In 1982, the U.S. brought an antitrust case against the American Telephone & Telegraph company, saying the company had a monopoly over phone services in the U.S. and was using its market power to price services unfairly. As a result, the company was ordered to divest its local subsidiaries.
The U.S. and the European Union have both brought antitrust cases against Microsoft. In 2001, the U.S. government accused Microsoft of using its monopoly power and illegal practices to protect its market share in operating systems. Microsoft and the DOJ settled the case years later.
In October 2020, the U.S. Department of Justice filed an antitrust case against Google, claiming the company violated the Sherman Antitrust Act by using anti-competitive practices to protect its dominance as a search engine and its dominance in the market for search advertising. This case is expected to go to trial later this year and will likely be one of the most influential antitrust cases to date.
Outlier (from the co-founder of MasterClass) has brought together some of the world's best instructors, game designers, and filmmakers to create the future of online college.
Check out these related courses:
Economics
Learn what a perfectly competitive firm is, how they make output decisions, and how they determine the highest profit by comparing total revenue and total cost.
Subject Matter Expert
Economics
Learn what relative elasticity is, the factors that influence it, and the difference between perfectly elastic and perfectly inelastic demand.
Subject Matter Expert
Economics
This article explains what equilibrium means in microeconomics. Learn what equilibrium looks like in the economic model of supply and demand under perfect competition.
Subject Matter Expert